Relative Strength Strategy
What is it with these terms being similar?
Not to confuse Relative Strength Index (RSI) with Relative Strength Strategy, they are two different things. The RSI measures the speed and change of price of an asset based on historical performance. The Relative Strength Strategy is utilized when looking at market, sector, and stock to make investment decisions.
So, what does Relative Strength Strategy entail? It is used to measure the performance of a stock in comparison to another, typically an entire sector.
Let's take $XLE, my current open contract that happens to be an ETF and apply the Relative Strength method for analysis. In the below table, I am providing a breakdown of the top three stocks that lead $XLE.
| Sector | Market | Stock | Percentage |
|---|---|---|---|
| Energy | Oil, Gas, Consumable Fuel | $XOM | ~25% |
| Energy | Oil, Gas, Consumable Fuel | $CVX | ~18% |
| Energy | Oil, Gas, Consumable Fuel | $COP | ~7% |
For some knowledge, $XLE is composed of roughly 24 stocks, but the three above are the ones with the greatest percentage make-up.
Why is it important that we know the top stocks of an ETF or sector? Different reasons, one of them being that it allows us to invest more intelligently. For example, if we were to invest in one sector, it is important that we understand the performance of the top holdings. The reason being, that the strongest holdings can impact the performance of the sector in which they are grouped under, in my case, $XLE. On the other hand, if we go to the micro level, and we invest in one specific, stock out of the entire sector, it is still relevant for us to compare the performance to the macro level.
Let's begin the analysis for this.
Today's Prices & Ratios| Stock | Price | XLE Price | Relative Strength = Stock Price/XLE |
|---|---|---|---|
| $XOM | $148.35 | $54.35 | 2.7 |
| $CVX | $183.74 | $54.35 | 3.38 |
| $COP | $111.43 | $54.35 | 2.05 |
| Stock | Price | XLE Price | Relative Strength = Stock Price/XLE |
|---|---|---|---|
| $XOM | $151.21 | $53.64 | 2.81 |
| $CVX | $182.60 | $53.64 | 3.40 |
| $COP | $108.70 | $53.64 | 2.02 |
When looking at prices for the three main stocks from last week and today, and comparing them to XLE, we obtain a ratio. This can tell us the performance of the ETF and the stocks at the same time. For example, We know that CVX, and COP increased by ~0.02 and ~0.03 respectively. On the other hand, we see that XOM decreased by ~0.1 If we take the average ratio today, we obtain 2.71 whereas last week we have a 2.74. So in comparison to February 9, today our ratio decreased by ~0.03.
When looking at the stocks separately, if I would've invested in $XOM only, I would've potentially lost money by today given that it decreased by $3. However, because there are other stocks (CVX and COP) helping fuel the entire sector, the impact is not drastic. This is a good thing.
So, when the overall ratio decreases, it tells us that the sector is doing better than the individual stocks, when the ratio increases, it means the individual stocks are outperforming the entire sector. In this case, given that our ratio decreased slightly, it tells us that our XLE is outperforming the big three.
It's interesting to see this breakdown, and it definitely pushes me to want to focus more on sectors rather than individual stocks. Either way, I think I'll go for both once the size of my bank grows. The market finally opens tomorrow, and I am excited to see where XLE takes us.
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